Ask An Ex-Banker: Use Savings Or Debt To Pay For School?

Note: An ex-student of mine reached out to ask a question many face… Is it best to use savings and investments for graduate school, or to take out loans?

Dear Banker, 

I saw you answered  a question from a former student about paying down debt and being unemployed on your blog. So I thought I would give it a shot! I am going back to school in January for 1  year accelerated program that will cost 40k-50k, I am not quite sure yet.
Side note: I thankfully do not have loans from undergrad. 
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So I will have to take out student loans but I am unsure if I should take out the whole 40k-50k or use some of my assets to have less debt after I finish.  
I currently have $9,000 in Betterment.com and individual investments with Capital One, $12,000 in Mairs and Power mutual fund that my parents put money in since I was a child. I also have $3,000 dollars in my savings account. I know I shouldn’t use all the money I’ve invested and saved but I was thinking maybe $10,000 dollars to have less students loans to pay back? I’m not sure what is a better decision financially. What would you suggest?
As well, I am going back to school to be a nurse so I can assume that my salary will be around 50k-60k a year. According to this website http://www.allnursingschools.com/nursing-careers/registered-nursing/salary/
I saw your blog on Facebook and thought I would ask!
Thanks,
M.C. (San Antonio, TX)

Hi MC,

Thanks for your question and for thinking of me. I’d like to think a few of the things we talked about in class were helpful.

I hope post-College life is treating you well. Congrats on having real savings and investments at this point…this is really commendable. Plus, no undergrad debt is also a blessing. A good place to be! About your future decision to use savings vs. take out debt for a nursing degree:

I don’t think there’s a single obvious solution. You could approach this various ways and still be making the ‘right’ choice. Also, I’d probably need more info on your situation to give more confident advice. But, here’s the principles I would keep in mind:

1. Student loans – especially for a professional upgrade in skills – are not “bad debt.” Mostly they have low interest rates, with generous payback terms. If they help you achieve a good salary and life-satisfaction, they are “good debt.” $50K of nursing school debt is a lot, but manageable in the long run. The fact that you’ve got some savings and investments already also suggests that you are able to live below your means, which bodes well for your ability to pay back debt over time after you get training and when you are earning money again.

2. If any of your Betterment, Capital One, or Mairs & Power accounts investments are in retirement accounts –  tax advantaged accounts like an IRA – don’t take any money out of there to spend now. You might pay taxes and penalties to extract the money, so its better to leave those for the next 40 years to accumulate compound returns.

3. For invested money not in retirement accounts, its ok to take the money out and spend some on a worthy project like a professional upgrade. BUT…if you’re able to resist taking money out, it’s better for you in the long run. It’s so very difficult to actually accumulate savings and investments – especially when you’re in your twenties – that I think you should try extremely hard to preserve it, invested in the markets. This will mean more debt (and therefore more risk) but it seems justifiable, at least to me.

4. Leaving money invested in stocks/ mutual funds is tax efficient (meaning, every time you sell you’ll owe taxes on the gains.).

5. It’s also slightly riskier (stocks/mutual funds can lose value). But the longer you can leave them alone untouched, the better your prospects for building wealth with that money.

6. I think, psychologically, its easier to save and invest if you already have something saved, rather than zero. So I wouldn’t want you to go to zero on your investments.

Those are my thoughts. Feel free to write back or call if you want to discuss/clarify/argue about any of this.

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By the way, how do you like Betterment? I haven’t really explored it but it seems like the targeted solution for your demographic. I’ve been enjoying an app called Acorns which I quite like. I wrote about it here: http://www.bankers-anonymous.com/blog/check-out-this-acorns-thing/

Michael

MC’s response:

Thanks so much for getting back to me! I’m sorry it took me a while to respond I went away for a week right when you wrote me back. 
I was thinking that it would be better in the long run to not touch my investments but taking out such a big loan does make me nauseous when I think about it. However, I think I will stick with that strategy because I know if I leave nursing school with no savings I won’t feel good about that either.  Thanks for going through the pros and cons its way more helpful then my internet searches have been!
I don’t have an IRA right now but I know I should set up a Roth IRA soon but I wasn’t sure yet if I wanted to use that money for school.
As for Betterment, I really like it! I started an account in August 2011 and just give about 60 dollars a month. According to my performance chart my return rate is 37% with an allocation of 100% in stocks. If I had 80% stock and 20% bonds it would be 44% right now. My original allocation was actually 70% stocks and 30% bonds but after your class I decided to try 100% stocks which, just like Acorns, Betterment refers to as ‘aggressive”. The majority of the investments are in different Vanguard funds and iShares. I like that part of it as well because if I’m not mistaken to open these account individually sometimes you need 1,000 or up to 3,000 dollars. I think Betterment is great for people my age! I always tell my friends to sign up who don’t know anything about investing. 
Thanks again for responding and teaching a great class I think all students should be required to take it!
MC
 —
MC, Ok good luck! You’re going to do great, because you’ve already done the hard part, which is to begin saving and investing in your early 20s.
–Michael

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As An Ex-Banker: Student Loan Repayment

Hello Professor!

This is your former student, one year post personal finance class, and I am in need of advice.

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Here’s the backstory. After spending one year in the IT Consulting world, making 70K and being equally stressed to the detriment of my health, I jumped ship (per the advice of my employer, they noticed I wasn’t sleeping). I left on good terms and with a fair severance pay. At this point of life re-evaluation I like the idea of taking however much time is necessary to ensure that misery is not a part of my daily routine at my next gig.

 

I have about 30K in student loans not paid off, interest rates ranging from 3.4% to 5%. The actual breakdown:

  • Loan A, minimum monthly payment $130/mo for 120 months: [12K @ 5%];
  • Loan B, total 18K, minimum monthly payment for all of Loan B $150/mo for 120 months [10K @ 3.4%, 5K @ 4%, and 3K @ 4.5%]).

My monthly expenses run between 1K to 1.5K and I have around 15K in savings (not including emergency funds, which is 3K and then 4K in a HSA account which can only be used for health expenses, I’m wanting to use all of that 15K towards paying off loans).

What advice do you have for planning my budget? I want to remove as much principal from my loans now to lower my interest payments. I may be able to defer paying monthly payments with no interest accruing for both my loans citing unemployment as the reason, another case might involve interest accruing as normal but monthly payment not required.

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Any and all advice would be appreciated, thank you! Let me know if any of this info needs clarifying.

Sincerely,

AF in Houston

——————

Dear AF,

Thanks for reaching out, I’m glad to hear you’re continuing to track a lot of the things we discussed in the Personal Finance course last year.

Congrats on building that cash cushion – that’s admirable and rare for anyone one year out of college. It sounds like unemployment is not as scary to you as being stressed out – so the cash cushion allows you to take some time to figure out the next step, which is really great.

The way I read your note, you mentioned three financial factors you’re trying to optimize, and then a few more unmentioned financial factors that I think you should include in the mix for decision-making.

Your mentioned factors:
1. Cash burn of $1,500 cost/month (aka unemployment)
2. $30K student loans
3. $15K savings

Your unmentioned factors:
1. Maxing out your Individual IRA when at you’re age 23
2. Finding work that covers your lifestyle costs and doesn’t leave you stressed out and unhealthy.

So…as far as important financial decisions in the next year, the most important is probably solving the issue of cash burn. You’ve got ten months, at your reported run rate, to solve that one (That’s $15K divided by 1.5K per month).
Ideally, you combine employment with the unmentioned factor #2, namely getting work that pays and keeps you healthy. Until you solve that one, I wouldn’t get aggressive about paying down your students loans.

Why do I say that?
If you decide to use your $15K cushion to pay down student loan debt, you shorten the time you have to get good, healthy work. Finding good work can take time. You don’t necessarily want to take another job that doesn’t suit you, and leaves you stressed out again, if you’re forced into the next job by the problem of running out of cash.
In addition, it’s very admirable to want to pay down your student loan debts with your savings, but in this particular situation I wouldn’t advocate that. Your student loan debt is low-interest debt, meaning it is compatible with good long-term financial decisions. (If you told me you had $30K in high-interest credit card debt, or any amount of credit card debt for that matter, I’d be strongly advocating paying that down as quickly as possible, as priority #1)
Then there’s another – in my opinion better – use for your savings if you’re trying to maximize your financial situation with your cash.

You didn’t mention contributing toward your $5,500 limit in an individual IRA. Hopefully you remember our discussion in class on the compounding effect of growing that money over the next 50 years. (Undoubtedly you can still do the math that shows your $5,500 becoming $101,311 fifty years from now at a reasonable 6% compound growth rate. Right? Please tell me yes.) Combine that with the 25% income tax relief you’d get on making a $5,500 contribution this year (so, up to $1,375 that you keep, not the federal government) and I think a strong case could be made for prioritizing your IRA contribution over student loan principal repayment.

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Obviously you have to stay current on your student loans, but I don’t think its a bad idea to pay the minimal required amount, at least until you figure our your employment situation.

An implied part of my calculation here is that, given your education and past earning power, you’re capable of getting a high-paying job in the next year. The trickier part – in the long run – is finding a high-paying job that doesn’t leave you stressed and unhealthy.

My summary thoughts would advocate either of the following to routes:
The cautious approach – Hoard your cash long enough to get a good job, pay the minimum on your student loans, but don’t pay down principal on that debt until you’ve figured out how much your new job pays.

The more aggressive wealth-building approach – contribute generously to your Individual IRA (up to $5,500) and keep the rest in cash. That leaves you more like only 6 months to solve the cash burn problem (aka unemployment), but hopefully that’s enough time for a smart guy like you.

Feel free to write back and ask for more clarifications or even to challenge my assumptions.
Best of luck and keep me informed!

Michael

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